I was in Southern California for the last couple of days and got to see how the economy was doing on the ground. Although consumers are not overly confident with respect to the economy, they do seem to be spending in the region (this contrasts with the rest of the U.S. where retail spending has been weaker than expected). So, why are we seeing sustained consumer activity in Southern California? It might be because of the “wealth effect” and how it pertains to housing.

Southern California has recently seen a spike in housing prices. Just a quick look at www.zillow.com will confirm this. The Fed’s Quantitative Easing policy of money-printing appears to have gained traction by injecting more optimism into the region’s housing market. It should also be noted that Southern California was hit harder than a lot of other areas, such as the U.S. Pacific Northwest, during the collapse of the subprime housing bubble. As a result, it was starting from a lower base and more likely to add QE-inspired gains.

However, much of the revival in Southern California housing prices is sugar-coated by perception. As the first graph above illustrates, the move up in prices since 2009 has been impressive. Buying a house as an investment doesn’t look all that risky. And, with all the emotional enticements of real estate, potential buyers are not inclined to broaden their historical perspective (unless they were hurt by real estate during the crash). If we look at the second graph, the last 13 years of house prices in the region tell a different story. We are still 25% below the 2006 peak and only back to mid-2004 prices. That’s over nine-years of going nowhere while paying Southern California’s famously high property taxes all the way along!

The region is going to need substantially improved economic growth and employment growth in order to sustain recent gains. Without that, all eyes will eventually focus on where these gains came from: Quantitative Easing. And, to the chagrin of the Fed, those eyes will constantly be handicapping the eventual end of Quantitative Easing and begin to make investment/spending/home-buying decisions long before that.

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